A cut to kick demand into a higher gear

Mark Bouris

ON TUESDAY, I predict, the Reserve Bank of Australia (RBA) will cut official interest rates by a quarter or half of a percentage point.

Every month, the RBA board meets to decide the cash rate for the next month and usually they have to be talked into cutting interest rates. But I believe there are now so many indicators pointing to a rate cut that the board would have to be talked into holding.

First, let's look at the official figures. The Reserve follows a whole lot of economic data when it makes these decisions but the number they focus on is inflation, taken from the consumer price index (CPI).

The March quarter CPI came out last Tuesday and it printed an inflation number well below what most economists were expecting. Out of 22 working economists polled by Bloomberg before the March CPI, none of them predicted inflation less than 0.5 per cent and the highest was 0.7 per cent.

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So, when the March CPI came in at 0.35 per cent (average of the weighted median and trimmed mean), the result took the market by surprise. It was almost half of the polled average. It means demand for goods and services is sufficiently soft and that prices are not being pushed up as expected.

The second point is what this means for inflation and the RBA's decision on Tuesday. The Reserve is bound to use monetary policy to keep inflation in the target range of 2 per cent to 3 per cent. And the March CPI means core inflation becomes 2.2 per cent.

So inflation is now in the lower part of the target range.

It means Australians are being careful with their money, shopping around, forgoing luxuries and staying out of debt.

They're only buying what they have to buy.

When this is the trend, the economy is not being stimulated by demand and it is time to give demand a kick-start. How? By reducing the price of money - the cash rate - and hoping that Australians will spend more.

This is the current CPI and inflation situation. But there are other indicators that the Reserve could be looking at if it needs a push towards a rate cut. I call these my indicators of the real economy.

How do I collect this information? I walk down a high street, I talk to business owners and I look at the "For Lease" signs, the "closing down sale" signs and the "50 per cent off" specials that are in the front window.

I look for empty shops, car yards with no people in them and bank boards on the footpath that spruik their deposit rates, not their variable mortgage rates.

I look at the newspapers: who's being laid off? Motor vehicle workers and bank staff.

These indicators tell a story of struggling businesses and cautious consumers.

This sort of dynamic can become a nasty spiral if it's not broken at the right time, because consumers become even more cautious with their money and businesses wear the consequences, having to lay-off staff, which feeds greater consumer uncertainty and leads to a worse climate for businesses.

With my view of the real economy and the CPI and inflation figures, I think it's time to break the spiral. When you have large concerns such as Westpac, Toyota and Harvey Norman talking about a downturn in consumer demand, you have to multiply that stress several times to glimpse what the average small business owner is going through.

Most business owners have to lay-off staff or eat into personal savings and equity in the family home to get through the tough times and this is what we're facing at the moment in Australia. It's a dangerous position, because our 3.5 million business owners are our biggest employers.

They need respite: we can't wave a magic wand but we can cut the cash rate, making borrowing easier for them and for householders.

Of course, whether the major banks choose to pass on this cut is a different story.

But while you can't affect what the Reserve Bank does, or what the major banks do, you can use a rate cut to your advantage.

If you're not financially stressed, you can continue to make your normal repayment even after the bank cuts your variable rate.

A 0.25 percentage point cut on a 30-year $300,000 loan at 7.4 per cent will save you about $50 a month, worth $18,000 over the life of the loan.

A 0.5 percentage point cut will save you $101 a month, worth $36,000 over the life of a loan. You can't change the RBA or what your bank does, but you can put the interest rate savings straight back into the mortgage or into a high-interest term-deposit account.